Maybe New Zealand Can Solve Housing Bubbles

By William Pesek -
Sep 23, 2013

As the world’s biggest economies
search for ways to let the air out of giant asset bubbles, they
might find some answers in tiny New Zealand. (NZOCR)

Fittingly, the nation that begins the developed world’s day
and the central bank that pioneered inflation targeting will
probably be the first to raise short-term interest rates. The
move could come next year as growth steadily returns to levels
seen before the collapse of Lehman Brothers Holdings Inc. in
2008. But something far more interesting is afoot at the Reserve
Bank of New Zealand’s headquarters in Wellington.

Faced with a scary housing bubble not terribly unlike that
in the U.S. five years back, Governor Graeme Wheeler should be
tapping the brakes now, and hard, or so holds classical monetary
theory. Doing so, however, would jeopardize the nation’s 2.5
percent growth amid general global uncertainty. Instead, Wheeler
is conducting an experiment: limits on leveraged lending.

The idea, says economist Stephen Koukoulas, is to “contain
the house price bubble without inflicting collateral damage to
the rest of the economy.” Koukoulas was an economic adviser to
Julia Gillard, Australia’s prime minister until June. And it’s
significant that he’s recommending that Australia’s much larger
economy emulate New Zealand’s experiment.

What about the rest of Asia, including China, home to some
of the biggest property bubbles in modern history?

Crisis Lessons

If the world learned anything from the crises of the last
20 years -- from Latin America to Asia to North America to
Europe -- it’s the folly of one-size-fits-all remedies. Nor is
there obvious utility to comparing a $160 billion first-world
economy like New Zealand’s with an $8.2 trillion developing one
managed by Communist Party bureaucrats and a state-run central
bank.

But the mechanics of monetary policy are rapidly changing.
Now that central banks have cut rates to zero, they are loath to
use them to address bubbles for fear of wrecking the broader
economy. In the best of times, monetary policy is a blunt
instrument. Today’s uncertain times require more of a scalpel --
something that the wonkish among us call “macroprudential
policies.”

“The neoclassical synthesis, the idea that we can use
monetary and fiscal policy to make the world safe for laissez-faire everywhere else, has failed the test,” Nobel laureate
Paul Krugman wrote on his blog last month. “What does this
mean? At the very least it means that we need macroprudential
policies -- regulations and taxes designed to limit the risk of
crisis -- even during good years, because we now know that we
can’t count on an effective cleanup when crisis strikes. And I
don’t just mean banking regulation. The logic of this argument
calls for policies that discourage leverage in general, capital
controls to limit foreign borrowing, and more.”

The International Monetary Fund made a similar argument in
a report last week, and New Zealand is a case in point. In May,
the Organization for Economic Cooperation and Development said
Kiwi homes were the fourth most overvalued in the developed
world, behind only Belgium, Norway and Canada.

True, Canada -- along with Israel, Singapore and South
Korea -- has tried its hands at macroprudential tweaks, but with
limited success. New Zealand’s are taking the form of what
bankers are calling a “10/80 rule,” whereby only 10 percent of
new mortgages underwritten can have to loan-to-valuation ratios
of more than 80 percent. The measures are designed to cap
household debt as much as head off an asset bubble.

Tighter Leverage

This general idea -- clamping down on low-deposit borrowers
-- may be applicable elsewhere. Had Spain taken such creative
steps in the mid-2000s it might have avoided a crash. Recent
history in the U.S. would have been very different with a 10/80
rule. Tighter leverage requirements mean fewer high-risk
mortgages for Wall Street to securitize into toxic debt
instruments. It would be harder, meanwhile, for Chinese families
to buy a second or third property in Shanghai (CNGDPYOY), Singapore or
Sydney.

New Zealand is pushing the envelope by making penalties
harsh: Banks will lose their licenses if they skirt lending
rules that go into effect on Oct. 1. That already has the
industry policing itself. The New Zealand Herald reported last
week that banks have “started tightening up their lending
criteria” for fear of even approaching the upper limit of
lending ceilings.

A similar dynamic could well end Wall Street’s too-big-to-fail gravy train. Mandating firm limits on banks’ leverage
ratios would do more than anything else to keep 2008 from
happening again.

Imagine if Hong Kong unveiled such measures to puncture its
swelling housing bubble. Or if the Bank of Thailand could head
off its own in Bangkok. And what of China? Its challenge is less
about low-deposit borrowers than cash-rich ones loading up on
speculative investments. Higher People’s Bank of China rates and
administrative steps have lost their potency. Imposing specific
and strict limits on speculation -- with higher taxes, if
necessary -- might do the job.

Asian policy makers also need to think creatively. China
gets 90 percent of its milk from New Zealand. It might want to
start importing banking ideas from the place, too.